Ross McGill: ‘FATCA isn’t the problem: CBT is’ 

 

 

 

Having been working in the cross-border tax area for the past 26 years, with and/or alongside many American expatriates and Accidental Americans, I totally understand why so many of them get so furious at being expected to pay hundreds, or even thousands, of dollars every year just to file a tax return with Uncle Sam.

 

After all, these Americans are already filing tax returns – and paying taxes – to the governments in the countries in which they currently live, and where they and their families make daily use of that country’s roads, government agencies, policing, public transport and other services, for which their taxes pay.

 

And it's not just the need to file U.S. tax returns every year either: sometimes expats find they're actually also expected to pay U.S. taxes on, for example, the sale of an overseas residence; or they might get hit with eye-watering penalties for failing to file or mis-filing such U.S. financial information forms as FBARs. And then there's the fact that being a U.S. citizen abroad makes investing for their retirement in a tax-efficient way almost impossible.

If expat Americans have a grievance, so-called accidental Americans are probably more annoyed because often, they didn't even know that they were technically considered to be American citizens – a fact that has come as a shock for many in recent years, when they tried, unsuccessfully it often turned out, to open a bank account. (Typically everything stopped when they got to the account-opening question about where they were born, or if they had a U.S. parent, or an unrevoked or unexpired Green Card.) 

In other words, FATCA has had a disproportionate effect on expats and accidental Americans, and a major reason for this is because banks don’t like risk (and they're not keen on extra-territorial regulation either).

 

The result has been a progressive “offboarding” of Americans and accidental Americans, which began as soon as FATCA was signed into law (once people began to realize it was there), and it continues unabated today. In response, American citizenship revocations and renunciations (including by "accidentals") have sky-rocketed.

 

The thing is...FATCA by itself is NOT the problem.

 

Rather, FATCA is simply the tool that enabled the U.S. government to, for the first time, enforce tax and anti-money-laundering laws that had been on the books for years. (Citizenship-based taxation, in fact, dates back to the U.S. Civil War.)

 

Nor was FATCA ever aimed at expatriate Americans, but rather, it was conceived to end the use by stateside Americans of overseas institutions to hide their wealth, as noted above. 

 

That FATCA has disenfranchised hundreds of thousands of American expats, who are finding it increasingly impossible to live and work abroad, was an unintended, if significant, side effect.

FATCA is, in fact, a sledgehammer being used to crack a nut – and, as has been pointed out recently by various commentators, it’s a sledgehammer that’s not actually working at achieving what it was intended to.

 

The real problem is America's citizenship-based tax system, which is what makes FATCA so toxic to Americans living outside of the U.S. 

Two parts of FATCA's
anti-tax evasion strategy

FATCA targets tax evasion by American citizens in two ways. The first way it does this is by obliging all Americans, whether they're at home or living abroad, to report any financial accounts they hold "overseas", i.e., outside of the U.S.

 

The second way is by compelling financial institutions in all other countries around the world to report to the U.S. any and all accounts they hold on behalf of American citizens, wherever they live, so that, in principle, the IRS can join up the dots, and figure out who is evading U.S. taxes.

 

Thus far, it's not working terribly well, according to the IRS, which earlier this year provided evidence to a Senate Finance Committee hearing suggesting such a conclusion, citing chronic under-funding and under-resourcing – i.e., no budget.

Within weeks, the U.S. Treasury Inspector General for Tax Administration concurred, in its own report.

Meanwhile, the U.S. is in breach of certain reciprocal information-sharing obligations it theoretically agreed to when it introduced the Intergovernmental Agreements (IGAs) that detail how FATCA is to be enforced by the various countries around the world that have signed up to it. 

Unlike these countries, all of which have signed FATCA IGAs with the U.S., the U.S. has not enacted domestic legislation to force U.S. financial institutions to collect and share information about non-resident account holders (that is, account holders who are citizens of countries other than the U.S. who also live outside of the U.S., but who have bank or other financial accounts in U.S. institutions).

The problem, at least for those of us who believe that people should pay taxes in the jurisdiction in which they benefit from the services that their taxes provide for – rather than to a country where they may happened to have been born, years ago, or from which one of their parents was from – is that the United States's stubborn insistence on keeping it's citizenship-based taxation regime is not just out of step with virtually every other country on the planet, but unfair to the other countries that have signed up to FATCA, as well as to America's own expats and accidental Americans. 

The result is that American citizens living abroad get caught by the fact that the country they live in taxes based on permanent residency, while the U.S. demands an annual tax return, occasional taxes, and the filing of various information documents such as FBARs as well, all because of their citizenship. 

 Perhaps not surprisingly, this has resulted in years of furor in the European Union, and a number of aggressive  lobbying strategies. The lobbying strategies and arguments most commonly used to try to have FATCA’s effect diminished or repealed have included:

 

      •  You must repeal FATCA because of its over-reach, and because it violates the privacy rights of the individual in question (as set forth in data protection laws promulgated by various governmental entities, such as, in Europe, the European Union)

 

      •  You can’t share U.S. data with the U.S. because I am an EU resident, so data protection (General Data Protection Regulation, or GDPR) rules are in force, and therefore, all the U.S. citizen has to do is not give their consent to the transfer of their data

 

      •   The U.S. government is deliberately obstructing the administrative process of renouncing U.S. citizenship, by making it too difficult, time-consuming and too expensive

      • The reporting of US citizens by financial institutions must be diminished because the US has not lived up to its side of the IGA bargain

 

All these arguments are, to a lesser or greater extent, valid arguments: unfortunately, they just don’t address the problem.

 

Not being an American citizen myself, I hesitate to get involved in the politics here. Still, as an observer, I can’t help thinking that Washington lawmakers ought to prioritize moving the U.S. to a residence-based tax regime, given the cost, misery and other effects that the current system is continuing to cause.

 

After all, as mentioned above, the U.S. CBT regime dates back to the U.S. Civil War, when it was introduced to help pay the costs of that military conflict. 

 

And while it's true that the OECD was quick to introduce its own anti-tax evasion regime based on FATCA, when it did so, it never even mentioned the U.S. CBT regime.

 

In fact, there has been a lot of commentary that the U.S. should ditch FATCA and join the OECD's CRS regime, (of which it is the only major non-participant.)

ting country).

 

The problem is that the U.S. can't, because the determination of reportability under the OECD's AEoI/CRS is based entirely on permanent residency, and not on citizenship.

In addition to being the sensible and fair thing to do, moving the U.S. to a residence-based tax regime and ending citizenship-based taxation would, many observers say, almost certainly put an end to the soaring rate of U.S. citizenship renunciations. I tend to agree, based on what I’ve heard from the U.S. expats I know. 

What’s more, as most of the expats reading this will know only too well, it's not just the annual obligation to file a U.S. tax return, bothersome and often expensive as that may be, nor the obligation to make sure one’s FATCA reporting obligations are taken care of. As mentioned, there are all those information documents: in addition to the FBARs (which are notorious for the persecutory penalties they can involve), these include such little-known reports as Form 3520s, aka “Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts". 

 

The case for the U.S. to move to a permanent, residence-based tax system, therefore, seems obvious. Once it does, it could then join the global OECD framework, and make life a lot easier for non-U.S. banks, which could then forget about FATCA, as there would be just one regulation to comply with.

 

The U.S. would still get the data it required to detect tax evasion on the part of U.S.-resident Americans and other U.S. resident individuals; expat Americans would no longer have to file annual income tax forms (although they would still have to file FBARs); and accidental Americans could at last drop out of the U.S. reporting system altogether. Expats and accidentals, meanwhile, would both find banking, investing, obtaining mortgages and so on far less problematic.

 

In short, FATCA’s purpose has not been met. Its implementation, though, due to its being implemented alongside America's CBT regime, has caused non-U.S. financial institutions to spend millions of dollars on enhanced due diligence, which in turn has led to hundreds of thousands of Americans being disenfranchised from having bank accounts in the country they have chosen to live and work in.

 

It also created an entirely new category of pariahs – accidental Americans – who have been similarly disenfranchised, in most cases for having merely been born on the wrong side of a border.

 

It has forced thousands of Americans and accidental Americans to go through the cost and hassle of giving up their U.S. citizenships. 

 I still say that I don’t regard it as unreasonable for governments to seek to keep track of wealth that their citizens may seek to hide, through whichever means, in order not to pay tax on it. Taxes are what pay for the things that make a country function, after all, and it’s not fair for those who have benefited disproportionately to seek to keep even more for themselves than they already have.

 

But in order for this to work properly, as we have seen, the U.S. has to replace its citizenship-based tax regime with one that is based on residency.

 

And the challenge, as I see it from this side of the pond, remains that of getting U.S. lawmakers to acknowledge this, and to move to fix it. 
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